Should You Invest in Stocks When You’re Near Retirement?

near retirement

The worst mistake an investor can make near retirement is to be too exposed to stocks.  We have only to look at the recent financial crisis to remind us that too much exposure to risk can bring a lifetime of savings tumbling down to almost nothing.

What 2008 Taught Us

Back in those pre-financial crisis days, when stocks were making people rich, investors near or at retirement age made mistakes we can learn from.  These were people who had enough saved for a comfortable retirement.  They had achieved financial success, benefited from the fantastic returns seen on stocks at that time, and were still investing in stocks.  In other words, they had made it, won the game, and were set for life, at or around age 60.

Yet instead of pulling those gains out and putting the money into safer, less risky investments, they continued to gamble in the stock market.  Liken it to actual gambling: they had already won but they kept playing cards.  Knowing when to stop is the most difficult part of gambling and also the hardest part of investing.  It’s especially hard when everyone around you is getting rich by continuing to play. Like the Kenny Rogers song: “know when to fold”.

However difficult it may be, pulling out in the midst of a bull market is exactly what we should do if we’re at or near retirement.  The people who lost money in 2008 did so because they didn’t know when to stop and couldn’t resist the great returns stocks were giving at that time.  Then when the crisis happened, they sold at the bottom.  Then they never bought back into the stock market because of fear.  2008 changed our way of thinking about stocks and it has taken the investing population several years to edge its way back into the market.  Our way of thinking about stocks, or risk, completely changed overnight.

The Life-Cycle Theory

The life cycle theory of investing states that how much risk you have in your portfolio depends on how much human capital you have.  Human capital is your earning power.  It’s your capacity to make more money.  As you get closer to retirement age, your human capital decreases.  You skills get rustier, you have fewer years left to invest and absorb risk, and perhaps even less ability to work at all.  After you retire, you have almost no human capital so your investing better be pretty risk-free.

And it’s not just about how many years you have left until retirement.  Let’s say you retire at age 62.  Well you may still have twenty or thirty years left, during which you can continue to invest.  Isn’t that plenty of time to recover from any loss you may see?

No, it’s not.  If you are retired, you are not earning any more money.  That means the only way you could recover from bad stock investments is to get lucky and experience a bull market immediately.  You will only have Social Security, and maybe a pension so you won’t be able to build up that fund again.

Not only that, but you’re also withdrawing from your retirement savings.  The typical withdrawal rate is 4%.  So, if you have a few years of bad returns on your investments, and meanwhile you’re drawing down your fund, the combined effect can wipe you out.

OK, Then How Much Is Enough?

Based on the The Four Percent Drawdown rule as laid out by famous financial planner Bill Bengen, you should not withdraw more than 4.2% of your savings in retirement.   Take your living expenses for a year, subtract what you’ll be getting in Social Security, and that figure is what you’ll need.  That figure should be 4.2% of your nest egg.

If you have achieved this amount and it can be sustained for twenty years or more, and still have money left over, then yes you can invest in riskier assets like stocks.  Otherwise, your portfolio should reflect the safety you require in your retirement years.

Author Bio

Belinda Mills loves to write about taxes, frugal living, and fashion.  More of her work can be found at irs-easy.com.

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